Greece's New-Bonds Era Arrives

When I met with Peter Eavis to talk Greece, we finished our conversation with a predictions game: what percentage of Greece’s bondholders would accept its exchange offer? He said 84%, I said 89%. He wins: Greece won the participation of 85.8% of Greek-law bondholders, by value, and 69% of foreign-law bonds. As a result, the vast majority of Greek bonds will end up being exchanged, since the collective action clauses on most foreign bonds and all Greek bonds will now be triggered.

Ideally, Greece would like to bail in all of its bondholders, and so to that end it’s extending its exchange offer for the bonds issued under foreign law, until March 23. (The March 20 deadline no longer matters, because that represented the maturity of a Greek-law bond, which is now being swapped into much longer-dated debt.) There’s a new restructuring offer, too, for “holders of Greek law governed bonds issued by state enterprises and guaranteed by the Republic”, which should deal with the Greek railways loophole.

The Greek press release hammers home why holdouts should tender into the exchange, with a statement from finance minister Evangelos Venizelos:

Our invitations to offer to exchange, and submit consents with respect to, foreign law governed and guaranteed bonds will remain open until 23 March 2012, after which there will be no further opportunity for creditors holding those instruments to benefit from the package of EFSF notes, co-financing and GDP linked securities which form an important and integral part of our invitations.

Remember that the Greece exchange is a package deal with three parts. For every old bond tendered, you get (a) a new Greek bond; (b) new EFSF bonds; and (c) new GDP warrants. Venizelos, here, is saying this is a use-it-or-lose-it opportunity to get all three in one. Greece may or may not continue to swap its old bonds for its new bonds even after March 23. But there’s no way that holdouts will get the EFSF bonds. And the EFSF bonds are actually worth more than the new Greek bonds.

Because Greece is activating its CACs, there will be a credit event for the purposes of its credit default swaps — as there should be. If you sold protection on Greek bonds, then you’ll end up having to pay out roughly 75 cents on the dollar. But given where the CDS have been trading of late, you’ve almost certainly put up that much money in margin already. So there’s nothing unexpected here, and there won’t be any nasty surprises on the CDS front.

The exit yield on Greece’s new bonds is roughly 20%, which means that even after this enormous haircut, markets are still pricing in a very high probability of default on the new bonds. (Which, remember, are all being issued under foreign law, and will therefore be much harder to exchange, next time round.) I suspect that the new bonds could be a buy at these levels. Not because Greece is suddenly fiscally healthy again: it isn’t. But because if and when Greece is forced to do another debt restructuring, maybe when it leaves the euro, the debt servicing costs on its new foreign-law bonds will be relatively small. And it will therefore be easier for Greece to simply keep on paying the interest on those bonds than it would be to try to restructure its bonded debt a second time round.

That’s the silver lining to the step-up coupon on the new bonds: because it starts so low, at just 2% through 2015 and 3% through 2020, Greece doesn’t actually help itself out very much, from a cashflow situation, if it defaults or restructures these things a second time. The pain of the next Greek default, then, is going to fall overwhelmingly on the official sector rather than the private sector.

Of course, if Greece defaults on say the bonds being held by the ECB, then it’s very unlikely that the new Greek bonds would be trading at healthy levels. But what that means is that when you’re looking at the depressed price of Greece’s new bonds, you’re looking mainly at market risk, rather than credit risk: the risk that they will go down in price is much more salient than the risk that they will simply stop paying out altogether. If you have a strong stomach, and can hold on through what will certainly be periods of very high volatility, then there’s a reasonably good chance they will actually pay out in full, over the medium term.

The first maturity date on the new bonds is 2023, and realistically Greece has no particular reason to default on the bonds until then. Even in 2023, the amount coming due is modest enough that Greece would be better off paying it than suffering the consequences of a redefault. Basically, in the wake of this exchange, the new bonds aren’t a big issue any more, from a fiscal perspective.

The really big problem, for Greece — the one which isn’t going away — is the fact that the country still has a massive budget deficit, and that the only people willing to lend Greece the money to cover that deficit, at least for the foreseeable future, are its fellow European sovereigns. And their patience is wearing extremely thin. That particular tension has not been resolved today, and it’s going to come to a head much sooner than any problems with Greece’s new bonds. The next Greek crisis is going to be a crisis with official-sector financing, and it could come as early as this year.

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